Navistar International Corporation
Q1 2017 Earnings Call Transcript

Published: 7 Mar 2017

[Operator:]

Good day, ladies and gentlemen, and welcome to the Navistar’s First Quarter 2017 Earnings Conference Call. At this time, all participant lines are in a listen-only mode to reduce background noise. But later, we’ll be holding a question-and-answer session after the prepared remarks and instructions will follow at that time. [Operator Instruction] As a reminder, this conference call is being recorded. I would now like to introduce your first speaker for today, Marty Ketelaar, Vice President of Investor Relations. You have the floor sir.

[Marty Ketelaar:]

Good morning everyone and thank you for joining us for Navistar’s first quarter 2017 conference call. Today, we will discuss the financial performance of Navistar International Corporation for the fiscal period ended January 31, 2017. And with me today are Troy Clarke, our Chairman, President and Chief Executive Officer; and Walter Borst, our Executive Vice President and Chief Financial Officer. After concluding our prepared remarks, we will take questions from participants. In addition to Troy and Walter, joining us today for the Q&A session are Persio Lisboa, Executive Vice President and Chief Operating Officer and Bill Kozek, President of Truck and Parts. Before we begin, I would like to cover a few items. A copy of this morning’s press release and the presentation slides has been posted to our Investor Relations website for reference. The non-GAAP financial measures discussed in this call are reconciled to the U.S. GAAP equivalent and can be found in the press release that we issued this morning, as well as in the appendix to the presentation slide deck. Finally today’s presentation includes some forward-looking statements about expectations for future performance. And the Company expressly disclaims any obligation to update these statements. Actual results could differ materially from those suggested by our comments made here. For additional information concerning factors that could cause actual results to differ materially from those included in today’s presentation, please refer to our most recent SEC filing. We’d also refer you to the Safe Harbor statement and other cautionary notes disclaimer presented in today’s material for more information on the subject. With that, I’d like to turn this call over to Troy Clarke for opening comments. Troy?

[Troy Clarke:]

Okay hey, thanks, Marty. We are really glad to have you on board. Good morning, everyone. I will start things off with some highlights for the quarter, then I will turn it over to Walter for more detail on the financials, and then we will take your questions. The headlines for this quarter are, we are off to a good start. We are on track with the plan that supports the guidance that we gave you all on the last call. Beyond financial performance, we continue to deliver on our new product launches, and we're seeing some green shoots or leading indicators that continue to bode well for improved market share. Since the start of the calendar year, we have taken advantage of a good market condition, to improve our cash position and re-price some of our debt, and we have now closed our alliance with Volkswagen Truck & Bus, and we are hitting the ground running to take full advantage of the new opportunities that the alliance provides. As we pointed out during our last call, we expected industry conditions in the Class 8 segment to be challenging in the first half of 2017. As we work through what we believe is the trough of the Class 8 cycle. In spite of those industry headwinds, we had a solid quarter. Our results came in slightly ahead of our internal plan, and are consistent with our full- year guidance. We expect these industry headwinds to continue in our second quarter. However, because of improvements to our break-even point, we are well-positioned for improved profitability in this second half of the year as the Class 8 industry rebounds. Recent ACT research data for February indicated that Class 8 market might be on its way to recovery later this year. Our order share continues to outpace market share, and our backlog grows, which gives us confidence in the retail share improvements to come. Our Q1 2017 order volume in our US and Canada truck markets increased 4% year-over-year. Customer response to our new products has been positive. We essentially doubled our penetration in the important rental and leasing segment, which is a very encouraging sign. And thanks to our new LT series on-highway tractor, we are back in the door with several large private carriers we haven't sold to in a number of years. We received more than 5,000 orders for the LT, and we have shipped approximately 2,500 units. Our parts team also posted another quarter of solid results, with substantial improvements in both our Fleetrite All-Makes business and our remanufactured parts business. Our Navistar defense unit recently won two significant foreign military contracts from the U.S. Army Contracting Command. The first is to produce and support the MaxxPro mine Resistant Ambush Protected vehicles or MRAPs for Pakistan, and the other is to reset, upgrade, and support MaxxPro MRAP vehicles for the United Arab Emirates. The combined value of these two contracts comes to more than $475 million. We are making good progress on the three parts of our strategy

[Walter Borst:]

Thank you Troy, and good morning everyone. Before we dive into the results for the quarter, I would like to echo Troy's excitement about the closing of the alliance with Volkswagen Truck & Bus. This alliance is a real game changer for us and the Volkswagen Truck & Bus team will be great partners. I hope you see, as I do, that this alliance will make Navistar a stronger, more competitive company. Now let's shift our focus to the results for the first quarter. Please note, additional details can be found on the slide deck we posted to the investor relations page of our website. As we discussed in December, we expected our first quarter, in fact, our first-half results to be challenged, due to the continued softness of the Class 8 industry that began in 2016. The results you saw this morning reflect the realization of that expectation. Consolidated revenues were $1.7 billion, down 6% compared to last year. The revenue decrease was largely driven by a 7% decline in our core charge outs to 10,200 units, but outpacing the US and Canada core industry volumes, which were down 18% year over year. Additionally, our global revenues continued to face economic headwinds. Our loss in diluted earnings per share from continued operations were $62 million, and per share respectively. The improved quality of our trucks on the road today is benefiting our results. During the quarter, we reversed $17 million of pre-existing warranty accruals, primarily related to lower claim frequency across both the medium duty and big bore engine families, as well as a one-time benefit related to our Brazilian engine operations. Excluding pre-existing, warranty expense as a percentage of manufacturing revenue was 2.9% this quarter. Adjusted EBITDA for the quarter was $55 million after excluding pre-existing warranties, and other charges related to impairments and restructurings. While these results were short of first-quarter 2016 results, they exceeded our internal targets, and we're pleased with our start in 2017. Turning to the results of our operating segments, lower Class 8 industry volumes, heavily impacted our truck segment. As a result, first-quarter sales were down 9% year-over-year to $1 billion. Segment's loss widened to $69 million this quarter, largely driven by lower volumes, partially offset by improved used truck results and continued material cost improvements. Additionally the prior year results included a $50 million benefit of a one-time fee from a third party. Our parts business is doing a terrific job growing new revenue streams, like our Fleetrite All-Makes brand, and the remaining factory parts business, to offset lower export and Mexico volumes. For the quarter, parts sales were $570 million, and segment profit was $149 million, both comparable to last year. Our global operations segment is doing a great job controlling costs. For the quarter, global operations achieved near breakeven results, even as revenues were down 46%. The year-over-year volume decline reflects the end of a customer contract early in the second quarter of 2016, and the ongoing difficult economic conditions in Brazil. The financial services segment is feeling the impact of the lower volumes from our manufacturing operations, and unfavorable movements in foreign exchange rates impacting its Mexico portfolio. As a result, Q1 revenues were down 8% to $54 million. Segment profit also fell this quarter to $30 million, reflecting the impact of lower interest margins, as well as the paydown of certain inter-company loans that had been a source of profit for this segment. Used truck inventory levels declined, for the third consecutive quarter, and we are managing trade receipts and aggressively pursuing sales opportunities, both domestically and abroad. Gross inventory fell to $388 million, a level not seen since October 2015. The decline was largely due to the receptivity of our used trucks in certain export markets. With reserves staying relatively flat, the net inventory balance fell to $177 million at the end of Q1, and we'll work to drive used over the balance of the year. Moving to manufacturing debt, this quarter we took advantage of market conditions to help provide ongoing financial flexibility by completing two capital markets transactions. First, in January, we closed a deal to tack on an additional $250 million to our existing 8.25% senior notes that come due in late 2021. Then in February, we were opportunistic in the market, and completed the repricing of our $1 billion term loan, which lowered interest expense by 150 basis points annually. All in all, we were able to raise additional liquidity without materially increasing interest expense. Since the benefit from the repricing largely offset the incremental interest expense from the debt issuance. These transactions helped solidify our capital structure, as we begin developing plans to address our upcoming debt maturities, beginning in late 2018. On the cash side, we ended the quarter with $697 million of manufacturing cash which includes the net cash from the tack on to the senior notes, but does not include the receipt of the $256 million equity injection from the Volkswagen Truck & Bus alliance that was completed in February. Therefore, on a pro forma basis to include this equity injection, we would have had approximately $950 million of cash exiting the first quarter, our seasonally weakest quarter of the year. In the quarter, the sequentially lower volumes resulted in net working capital being a use of cash. This, together with seasonally high interest payments and warranty spend in excess of expense more than offset the EBITDA generated by our operations, and the cash received from the incremental debt issuance. Looking forward, we expect to end 2017 with about $1 billion of manufacturing cash. In closing, we expect Class 8 industry headwinds to keep blowing in the second quarter, challenging our results against a very strong prior-year comparison. We do however expect improvement in the Class 8 industry volumes in the second half of the year, largely due to improved consumer confidence, reduced dealer inventories, improving OEM backlogs, better freight rates and growth in municipal spending. Therefore, we remain on track with our plan to further improve adjusted EBITDA this year. As we continue to grow our presence in the market with our new products, we have positioned ourselves to benefit once the Class 8 industry begins to turn. The closing of our strategic alliance with Volkswagen Truck & Bus marks an exciting new chapter in Navistar's history. The expected benefits of the alliance are not only readily apparent to us. In this regard, last week, both S&P and Fitch upgraded their credit ratings of the Company after the transaction closed. We look forward too many great opportunities that will come from this alliance, that will benefit both our customers and the Company, and in turn, drive greater shareholder value. Last we're planning to have an investor event at the North America Commercial vehicle show in Atlanta in late September. Please mark your calendars for Navistar's event on September 25, and stay tuned for information to come from our Investor Relations team. With that, I will turn it back to the operator to begin the Q&A.

[Operator:]

[Operator Instructions] Our first question comes from the line of Ann Duignan from J.P. Morgan.

[Unidentified Analyst:]

Hi, guys, this is Christie on for Ann Duignan.

[Troy Clarke:]

Hi, Christie.

[Unidentified Analyst:]

Can you layout the exact cadence of shipments by quarter for the recent the funds orders you have seen?

[Troy Clarke:]

Bill, you want to go ahead?

[Bill Kozek:]

Sure. Yes, Christie, this is Bill Kozek. We were awarded – we did awarded a number of contracts and really wasn't just the two, there was seven or eight more that we ordered since the beginning of November. Obviously as Troy said the first to produce and support the MRAPs for Pakistan and then the other one to reset the MaxxPros for UAE as you are aware of the majority of the works going to done in West Point. The first one – deliveries planned for 2017 calendar year and the UAE one will begin in the middle of this year and go through fiscal – exit through probably some of it will be done in 2019. So that one’s a little bit longer but really no change on our guidance for 2017 or 2018.

[Unidentified Analyst:]

Okay. And then secondly with growing talk around electric commercial vehicles especially in the transit bus space. What is Navistar's position and how big do think that market is today? And how big do think it will be in five years?

[Troy Clarke:]

Hi, this is Troy, Christie. I was just on the TMC and kind of gave a little talk, right that highlighted – I think what our thoughts are in our position is. Look I think the bottom line as the cost of electrical storage batteries continues to come down. It reaches a point where four short loop type transits, like buses, like school buses for instance or like pickup and delivery type thing especially within urban environments that electricity can become a compelling source of fuel basically for these vehicles. So to us the indicator to really watch is what’s the cost for storage or what they call the cost per kilowatt hour. And if in fact the industry is correct it has been coming down significantly like 14% per year for the last decade and 16% per year over the last two or three years then you could look to a period of time in the early part of the next decade where the cost of a battery in certain applications becomes very comparable to the cost – operating cost of a diesel engine. So we think it’s something that the industry has stated we all got our toes in the water so to speak and are kind of dabbling around in it. I think you can see – you'll see that as the industry goes forward. And I think you'll see the real commercial application or real segments where those are going to stick and maybe have great opportunity in the early part of the next – in the early part of the next decade.

[Unidentified Analyst:]

Okay, thank you for the color. I’ll pass it on.

[Operator:]

Thank you. Our next question comes from the line of Jeff Kaufman from Aegis Capital. Your line is open.

[Jeff Kaufman:]

Hi, guys. Well, congratulations on closing Volkswagen and congratulants to Persio as well. Real quick, Troy, did I mishear you, you said the value of these new defense contracts, I thought you were going to say $475 million but it sounded like trillion. Could you clarify that?

[Walter Borst:]

It was $475 million, million with an M – million with an M, Jeff. Thanks.

[Troy Clarke:]

I’m sorry, I thought I said million maybe…

[Jeff Kaufman:]

You may have – I may have misheard you and then secondly can I focus a little bit on the financing transactions Walter, you talked about the reversal in the warranty accrual and you identified two other charges but can you talk about maybe any other cost strategy had in the quarter whether it was related to debt refinancing or whether it was related to closing this Volkswagen transaction just to get a sense for kind of unusual below the line costs?

[Walter Borst:]

Yes, in our press release the charges for the quarter and year-over-year are highlighted they are relatively flat year-to-year so the decline year-over-year as really function of slightly lower volumes as we indicated as well as some lower profitability at NFC from the lower margins that we are experiencing there and the lower volumes coming from the manufacturing business.

[Jeff Kaufman:]

Okay, so you would say that $30 million more of a run rate not anything unusual?

[Walter Borst:]

There was some, we took some additional reserves for our Mexican portfolio so that might not be repeating but we have continue to see a runoff of the retail portfolio in the NFC and so we should expect the run rate to be lower at NFC this year than last.

[Jeff Kaufman:]

Okay. If I just for the reserves kind of run rate are we looking at there?

[Walter Borst:]

I'm not going to go there. Today Jeff, there was a small amount in the quarter.

[Jeff Kaufman:]

All right, Walter. Thank you guys congratulations. Thank you very much.

[Walter Borst:]

Thanks, Jeff.

[Troy Clarke:]

Thank you.

[Operator:]

Thank you. Our next question comes from the line of David Leiker from Baird. Your line is open.

[David Leiker:]

Hi, good morning everyone.

[Troy Clarke:]

Good morning, David.

[David Leiker:]

I wanted to walk through a bit if we could flush out the contribution margin here year-over-year if you make some of those adjustments year-over-year it’s still pretty big contribution margin, its not a low revenue number but can you help flush out a little bit?

[Troy Clarke:]

I’m not sure, exactly what you're getting at David. Help me out a little bit here.

[David Leiker:]

It is about a 50% decremental margin on the revenue decline. Again it is a relatively small revenue number but the impact of it is pretty meaningful. Maybe to pull out last year's income – the income from last year plus some of the warranty from this year and it is about a 50% decremental margin on the truck business?

[Troy Clarke:]

On the truck business, well, let’s talk about gross margin product.

[David Leiker:]

That’s a segment number that you referred for North America truck, we had follow-up offline another one…

[Troy Clarke:]

Yes, we had a one-time item last year, so we mentioned that $15 million and volumes are lower by about $100 million. So you just take a look at your normal margin that you have in your model for the truck business and I think you probably get to most of the year-over-year change.

[David Leiker:]

I guess, what I’m trying to go at this it looks like it would be something closer to quote-unquote normal type decremental margin which would imply some of the structural cost changes are being anniversaried and that this is probably more normal run rate for the business is that fair or are there still some margin opportunities some of the structural actions you have taken?

[Troy Clarke:]

Yes, well, I think first off what you are seeing David is in fact you're seeing inside the segment you are seeing a cleaner – you are seeing the business being coming a little cleaner, okay.

[David Leiker:]

Yes.

[Troy Clarke:]

We have fewer of those kinds of adjustments that are maybe inside the segment that are deterring from margins. So you're seeing the margins begin to lift to represent more in line with where we think that they should be and where they are going now that said it is not soup yet. We are not totally there yet. We still other opportunities. We continue to – we are still it is good to see the fact that some of the things that we've done already have in fact – are in fact showing themselves in a gross margin of our products but we still have action plans that were taken last year that have yet to kind of come to fruition. So we think we are going to see more of that. On top of that now we add the alliance stuff on top of that where we think there is real opportunities for additional material savings and I would say a stabilization of our engineering spend. So engineering spend won’t be so inflationary with new projects let’s say or volatile with new projects. In addition, I would like to point out when we launched new products they have a lower design cost than the products that they replace basically, higher function, lower design. And so the fact that we are still launching new products for the next 18 months indicates to us that our cost position will fundamentally change. We have also as we are launching new products continuing to invest in our manufacturing facilities to drive additional efficiencies and again with the GM project that we have unless its continue to thin some of that, now that thinning of the fixed cost really is just offsetting some lower volume at this particular point in time we are encouraged to see the improvement in gross there is a cause-and-effect to the things that we have done there is more to come largely because of the fact that we have new products and we still have actions that we have taken and I think the run on or that begins to ramp up some of the value of the alliance. I don't know Persio, am I saying this the right way? I'm trying to grab a couple of pieces of paper that I've got in front of me, David and summarize in a short period of time but we can give you additional detail on a follow-up after to you.

[David Leiker:]

You are perfect, Troy I think we are all super excited with the opportunity on the procurement side with a joint venture. I think that is actually the team hit the ground running and have everybody in the right place. We know where to get it started and the activity is taking place right now. We are not going to wait for future performance coming out of that team. So that’s number one, and your spot on the manufacturing side as well. I think a lot of the investments that we have made in the new products our investments made also in manufacturing which brings those products to life in a more effective cost base. That is happening today and better absorption that we're having with the launch of the G Van. So all of those things they pile up pretty well to what this – we're going to seeing the future in 2017.

[Troy Clarke:]

And then two things David, I don't know exactly how they factor right into that, but one is I think something very significant that Walter mentioned, this is a first quarter and some time we have actually had a reversal of accruals with regard to warranties. So again the investments in quality are paying off for us and customer service. So hopefully we are seeing better days than that. And then last but not least, I think very important to us inside the company, I think this is a big deal. In fact that we over the hump on that, we can see the end of it. This is a significant drag for our earnings for a period of time. And once that kind of comes of that’s I want to say its pretty money, but it certainly margin that we are counting on for our more normalized business.

[David Leiker:]

Great. And then just one quick follow-up on that, what do you think the timing is for the alliance savings to start to show up?

[Walter Borst:]

Well. We have said that we expect it to be accretive in the first 12 months of operation. And I think we will stand on that right now and give us the opportunity to surprise you guys with some good news as we work through implementing our early plans here.

[David Leiker:]

Okay, great. Thank you very much for taking the call. Appreciate it.

[Operator:]

Thank you. Our next question comes from the line of Steve Volkmann from Jefferies. Your line is open.

[Steve Volkmann:]

Hi, good morning, guys.

[Walter Borst:]

Steve. Good morning, Steve.

[Steve Volkmann:]

I was hoping I could get you to sort of expand a little bit on a couple things that you said in your prepared remarks. I think you said you are starting to see some green shoots relative to market share. I guess we haven't really seen that and the numbers yet, but I am curious if you may give us a little more detail as to what you are seeing and maybe which of your products we might expects if we look at Slide 13 and six months, where will we see a difference?

[Troy Clarke:]

Yes. Let me lead off and then I'm going to pass that over to Bill if I could who is up to his eyeballs in those numbers every day. Look he is the – here is the kind of things that I look at. One is, where is our quoting activity. Quoting activity was up from 2016 over 2015, that trend appears to be continuing and if not accelerating. For instance in 2016, we quoted 20 of the top 50 customers in the market with the largest customers, we quoted 20% more of them than we did the previous year. We got awarded 50% more than we did the previous year. And we had this concept called share wallet. Do I get the majority of thereby or not that increased nine fold in 2016 over 2015. And those trends are continuing. So that quoting activity continues to rise. Interest in our new LT product is up. I was at TMC last week and definitely there were people in and out of the truck all the time with very favorable comments. And these are the people who really make buying decisions, maintenance decisions. So we are very excited about that. Bill can elaborate more, but we've got customers talking to us who haven't talked to us for the better part of this decade. And they are interested in, not just our story, but in fact they are interested in what our products can do for their business. So these are all very encouraging signs. There kind of things that I would highlight as green suits. Our investments in up time, service quality, et cetera, beginning to pay off. And one of the things we look at is a leading indicator is order share, right. And our share of orders has increased in this quarter 4%. I think it was 4% year-over-year. Bill we will pass it to you.

[Bill Kozek:]

Yes, Steve. The market share I think the piece that I think you are eluding to is on the heavy piece and the big reason for the decline from fourth quarter to first quarter was we began ramping up production of the LT during Q1. So that caused the lower run of heavy product for us in the quarter. When you do that you can't get those into the retail numbers until get to the dealers and then we will start to see some share gains in heavy. Medium has been a success story for us. Our order share is significantly up over our retail share. And that’s continues to be a good story for us. And at the end, we are up just short of one percentage point year-over-year. I expect that to continue to grow. Backlog is up quarter-over-quarter in all segments by pretty good percentages. And during the fourth quarter Class A production share was over 13%, which is another positive sign for shared growth. We've got a lot of hard work to do, but we've got some new products, our dealer bodies engaged, there's been a lot of improved economic activity, certainly in the infrastructure space and I'm optimistic about shared growth for 2017.

[Troy Clarke:]

Yes. So if I could just add just one couple final comments, so that Steve kind of given Bill and his team all of the credit in the world. I am expecting we'll have share increase in the second where the HX participation, because we kind of launched late last year for the construction season. Today we stand here with kind of all configurations available and ready to participate in what we hope to be a robust construction season as the weather gets better in the northern part of the country. We expect continued gains in the LT with the X15 and over where the ProStar was and then basically our reentry to the 13-litre segment with the new A26 with deliveries available mid-year, couldn't pick a better time of the markets recovering in the second half of the year to have these kind of new products come about. We've really been kind of non-existent in that 13-litre segment and it has remained 50% and growing of the heavy on highway type market. So very specifically those three entries I think are going tell the mail. Very exciting we've got the our each launch coming I think a little bit later this year…

[Bill Kozek:]

Next month.

[Troy Clarke:]

Next month, and then of course the DuraStar replacement later in the year. So the hits just keep coming and I expect everyone of them has been a contributing tremendously to biomarkers there.

[Steve Volkmann:]

All right, great. I appreciate that. Maybe just a quick follow-up to go...

[Walter Borst:]

[indiscernible] to work with the sales guys lot here lately…

[Steve Volkmann:]

I was waiting for them, but I'm seeing FDA into that. So maybe just a quick follow-up for Bill, the last two or three months of orders for the overall industry have certainly been I think a little bit stronger than most people have been looking for. What are you hearing from customers? Why are they sort of re-stepping up and ordering more vehicles now. We don't see a lot more freight movement or there other things that are driving this in your feedback loop?

[Bill Kozek:]

Yes. I was at TMC last week as well. There is a lot of great customers there and almost to a person everybody's volumes are up year-over-year. The fact that we haven't had much of a winter in the central part of the U.S. is certainly help keep the freight moving. Now those same customers in the last 12 to 18 months have rightsized their fleet. So they have taken some of their volume out of the system in an effort to improve the rate. And haven't seen rate-improvements to date, however a number of our customers are saying, hey, that’s coming. It's just over the hill. The other piece is with all of the talk about infrastructure spending we are seeing more activity in our vocational and severe service vehicles. So that's been positive as well. And certainly the municipalities are purchasing more as well. So we're pretty optimistic that we bottomed out last year in terms of the truck market in 2017 will be strong.

[Steve Volkmann:]

Great, thanks. I'll pass it on. Thanks, guys.

[Operator:]

Thank you. Our next question comes from the line of Andrew Casey from Wells Fargo Securities. Your line is open.

[Andrew Casey:]

Thanks. Well, good morning, everybody.

[Troy Clarke:]

Good morning.

[Bill Kozek:]

Good morning.

[Andrew Casey:]

Couple questions on the A26 engine introduction. First, do you have some of these already running in fleets? Second, should we expect as that enters production to have a little bit more conservative warranty accrual that could drive let's say a clean warranty expense, above 3% of sales and I am just wondering how quickly do you expect to ramp up that A26 equipped LT truck because it, as you pointed out that could be a big shift potential for market share.

[Troy Clarke:]

Yes. I will start answering that. Andy first, we're going to be introducing it mid-year, and we do have a number of these vehicles running in customer fleet as well as our own test fleet and they’re performing extremely well. It is a quiet engine, it’s build for up time. The service intervals are improved and it is a lightweight engine. So we're excited in our – that’s what our customers want. In terms of the warranty accrual, I think it is going to be zero, but let’s have Walter answer that question and the third piece of that is probably a Persio question. So I will turn it to Walter first.

[Walter Borst:]

Yeah, with respect to warranty we are continuing to look to drive our overall warranty cost down. So we have been driving to 2.5% of sales. We have been steadily below 3% of sales. So taking together no change there in terms of where we want to go with our warranty spend and beyond that I'm sure Troy will push us to an even lower level to really be industry-leading in this area. So that together with uptime or really continue to be our focus on the quality side of the business.

[Persio Lisboa:]

And if I may add to that I think the engine itself is a simpler product. We reduced the hardware, we removed no components that were not necessary in it. We are using proven technologies all over the products. So we feel really good about the warranty and where the engine is going to perform when we launch in mid-2017. And regarding production we will be ready, we are just waiting for the orders to come because really that’s what we need and the plant is absolutely ready to grow, we have now gone through all the pilots that are required to validate our manufacturing process and we see really good about what we are seeing today.

[Troy Clarke:]

Yes. We actually, we’ve just opened the order book with the introduction of the engine but anecdotally number of customers that I have been that's had to be the good fortune to Bill and his team on have been waiting for this. They want the truck with lighter weight and the performance of the new A26, we don’t anticipated a warranty spike, we’ve tested and validated this product, I think as well as we’ve ever done anything it’s really been a labor of love I think for the folks who really look for an opportunity to show how good we can be at a product like this. In addition to that as we begin our discussions around the Volkswagen alliance, I’d remind you that the base or the platform of the engine is really derived from the MAN product and so we’ve had some level of technical exchange with our colleagues over there just to get their reaction to the kind of changes that we made to this engine and their responses have all been extremely positive and favorable to the engineering, not only engineering approach, but how we ended up working at the hard-line. We are really excited about this. And we think our customer is going to be excited about it as well. And it is important for us because it does represent an opportunity to get back into a very important segment of this market that we’ve really not had good representation for a couple of year's time.

[Andrew Casey:]

Okay, thank you. And then separately I am trying to understand the ending cash balance guidance. The implication of flat revenue for the year after being down modestly in the first quarter is growth for the combination of the last three quarters. And then on a pro forma basis FQ1 cash about $950 million coming out of this seasonally weak Q1. I am just wondering with that $1 billion kind of roughly flat with the end of Q1, are there any puts and takes we should consider that could way on the seasonally stronger cash generation later in the year or is this just more or less conservatism?

[Troy Clarke:]

Yes. We continue to expect to build cash over the balance of the year. I think the key thing here is that we’ve got a very solid liquidity balance with the equity injection and then the actions that we took in the first quarter. There were some payments related to the term loan repricing that will impact our second quarter. We’ve got some other items that pay there annually, related to compensation benefits otherwise of that will impact second quarter cash flows but, just really happy that we have been able to do with what we have been able to do on the liquidity front. And it puts us into good position to [indiscernible] strong.

[Andrew Casey:]

Okay, thank you very much.

[Operator:]

Thank you. Our next question comes from the line of Jerry Revich from Goldman Sachs. Your line is open.

[Ben Burud:]

Hi, everyone. This is Ben Burud on for Jerry Revich. Thanks for taking my questions. So, you guys called out margin declines, your Blue Diamond Parts as weighing on the parts segment. Can you just help frame the magnitude of those declines and maybe can you put some color on potential run rate going forward over the near term.

[Troy Clarke:]

Yes, we are not going to do anything on run rate related to Blue Diamond Parts. What we said is that we expect a gradual decline those revenues over time, but that really is over an extended period of time. So no news there that we haven’t talked about before. We are really excited about is that the Parts business overall continues to do very well and we do particularly well in the Fleetrite area of OMEX brand, as well as the manufacturing and parts business has continued to be a strong place for us. So, overall the parts segment continues to be very strong and we continue to expect that to do better this year than last.

[Ben Burud:]

Got it. And then can you guys give us a update on any stridence of your prior generation trucks. How many did you do last quarter and how do you see that shape me as going forward as well.

[Troy Clarke:]

Yes, the used business – some bad venue has been a very, very long journey, but we know we needed to take care of the customer. So we expect and I think we have told on this call before the number that we plan to take back. We are over 70% and starting to get over the 75% number of the vehicles that we expect to trade back. I think later this year, this calendar year we expect more normalization of our use truck business as we work through the MaxxForce 13 population. As Walter’s remarks said, we’ve add some success domestically, but the big success has come overseas and we continue to see activity overseas and in certain areas of the globe where these trucks perform very well. So no projection about where we are going to end up but with the activity that we have we think business – we are going to be ahead of a more normalized state of used truck business at the end of 2017.

[Ben Burud:]

Got it. Thank you.

[Operator:]

Thank you. Our next question comes from the line of Neil Frohnapple from Longbow Research. Your line is open.

[Neil Frohnapple:]

Hi, good morning. Just a follow-up to Andy’s question on the A26, I mean, can you talk about the benefits on the cost side to the new A26 engine versus N13. Is this going to drive higher material cost savings in FY2017 and you’re previously expecting in the guidance or OB offset by higher R& D cost.

[Persio Lisboa:]

Hey, Neil, this is Persio. As Troy alluded before, he mentioned that every time we launch new products, that’s a great opportunity for us to reduce design cost and A26 is no not different. I think we are very excited with the product – from a functionality standpoint and the benefits of the customers we will experienced, the light weight, the free economy – to deliver. And as I mentioned before we are taking significant hardware out of the product and we really believe that’s going to be one of the most competitive engines in the marketplace. So that we’ll make us more profitable, we’re very positive that the margins on the 30 meter segment. We can get better with A26.

[Neil Frohnapple:]

Okay. So that product was considered in the previous guidance.

[Troy Clarke:]

I mean, just for very – this is very simple example. The engine that it replaced was a compound in turbocharged engine. So we’d had two turbochargers on it. This is a variable geometry turbocharger on and it is one turbocharger on it. So when you look at the side of the engine there is about 100 Hz, I don’t think that literally but there is just a gob of stuff that is no longer hanging on the side of the engine. That is a technical term, gob a part. There’s a gob a parts no longer hanging on the side of the engine. That does a couple of things. One it reduces the fundamental cost of the engine, because there’s less material content in the engine. Two, it improves just reliability, because every time, we built something on, there’s an opportunity for something breakdown. So we anticipate better quality overtime. And then last but not least the engine becomes easier to assemble. So we delved into this design for manufacturing and the design for maintainability which I think when people see this engine under the cowl of one of our trucks it is striking how much better this engine looks and how much more understandable it is even to the novice.

[Neil Frohnapple:]

Okay and then just a follow-up on that I think Persio you mentioned the fuel economy savings, I mean, what some of the early touch data showing versus N13 and the coming 15 leaders?

[Persio Lisboa:]

Yes, we’re 7% better.

[Neil Frohnapple:]

Then the N13.

[Persio Lisboa:]

Yes, versus N13. And then we think extremely comparable through the [indiscernible] team. And this is a combination of day 26 in the new LT, which is performing better in the 15 leader as well. We are very excited about that.

[Neil Frohnapple:]

And one quick final one, maybe for Bill, you guys talked a lot about the improvements we’re seeing in the Class 8 market, particularly for the second half of the year. I guess, why not raise the full year Class 8 industry, I’ll look at this point is a still to early in the year just any thoughts there.

[Bill Kozek:]

Yes, it is still too early in the year. So many margins, one, some of the activity we’re seeing as we all know summer things start to slow down from an order intake, I don’t expect that to happen this, because there’s activity, but I also know I’m not ready to put my neck on the line by increasing the total industry yet.

[Troy Clarke:]

Yes, I think we have a factor that into our guidance. So, I think the way, I’d characterize this is that we are seeing more and more evidence that initial guidance that we have provided is directionally correct. So we already said back in December that we would expect to second half of the year to put strong our commentary are consistent with that.

[Neil Frohnapple:]

Okay. Great, thanks very much.

[Operator:]

Thank you. Our next question comes from the line of [indiscernible] from UBS. Your line is open.

[Unidentified Analyst:]

Hi, guys, thanks for taking the question. I’m call again to half of the Steven Fisher. In terms of on demand, can you tell us how much revenue the 270,000 customers are generating and then what percent of those accounts are revenue generating.

[Troy Clarke:]

Yes, I think the key on demand connection is just really that we continue to grow the base here, very considerably both for international customers and other customers, that’s going to put us in a good position going forward to really participate in the revenue stream as well as profitability stream in the connected vehicle space. So that’s not a significant amount to talk about yet, the key is just giving on as many vehicles as we can continuing to provide great services to our customer and looking to grow that business in a profitable way over time.

[Unidentified Analyst:]

And then we talked a lot about the cadence of second-half versus first-half. Can you just say if you expect to be profitable in the second half of the year? I’m just trying to get a sense of how much improvement you are expecting?

[Troy Clarke:]

Well our goal is surely to get profitability as soon as we can. But the key metric that we provided to all of you is that we plan to grow EBITDA for the year again for the fifth year at a row. And so we will see where that leads in terms of profitability obviously we can, moving EBITDA up and you’re going to see profitability there as well.

[Unidentified Analyst:]

Okay thanks very much guys.

[Operator:]

Okay. Our next question comes from the line of Robert Wertheimer from Barclays. Your line is open.

[Robert Wertheimer:]

Yes thanks. Just a question on the more normalized used truck trade and as you go into the end of 2017, is there sort of a function change process to get through the backlog losing money taking in that a hunt and how much that is costing you right now and I’m just curious if you think that is minor or material as you can quantify.

[Troy Clarke:]

Your question was a little garbled there. I think you are enquiring about in used truck and out we see that impacting profitability over the course of the year. Is that right?

[Robert Wertheimer:]

Yes, I’m so sorry, yes. Once get through the abnormal trade of used truck how much step function up on profitability might you expect?

[Troy Clarke:]

Yes, so a couple of things. One, we’re already seeing some benefit the year-on-year in used because we didn't need to take the same level of incremental reserves this quarter as we did, for example, a year ago. We’ve continued to Mark our portfolio to market. We do that every quarter to the best of our ability. And we would hope to have less and expect to have less incremental reserves for use this year than we did last year. Secondly, to your point as we continue to work through some of the MaxForce units that we had in our backlog and get some of new products back, we would expect that to go to more normal trade cycles and then to come back at more normal levels consistent with what we have seen historically. Overall we think to be favorable I know you year-over-year.

[Robert Wertheimer:]

Okay. And then just one quick small [indiscernible] or are you using any internet source from an external vendor, is that the one you guys had developed a few years ago?

[Troy Clarke:]

No. We don't, is not the one that we were developing some number of years.

[Robert Wertheimer:]

Perfect.

[Troy Clarke:]

That was actually part of a business unit that we have since – we no longer possess. And I don't believe or pursue that that product ever made it to market.

[Robert Wertheimer:]

No.

[Troy Clarke:]

That product never made it to market. Unfortunately when we were in that 2012, 2013 timeframe when we had to kind of pull in a little bit and get focused on being a great truck company we decided that could not continue to invest in that becoming a great component company at the same time.

[Robert Wertheimer:]

That is what I saw and that makes sense. Just triple checking. Thank you.

[Troy Clarke:]

There are some really good companies out there that have a lot of expertise in these type of products and part of our open integration philosophy that you heard us talk about probably more a couple of years ago was find who is got the best and avail yourself to their technology and their scale. And this is really an exercise in just that.

[Robert Wertheimer:]

Thanks.

[Operator:]

[Operator Instructions] We’ll be taking our next question from the line of Seth Weber from RBC Capital Markets. Your line is open.

[Seth Weber:]

Hey good morning. Hi everybody, thanks for taking the question. Most of the questions have been asked and answered. May be for Bill on the Class VIII pricing environment, the new trucks, you kind of reference market pressures in the press release but obviously the environment seems like it's getting better. Can you just sort of characterize the new truck pricing environment for Class VIII. Thank you.

[Troy Clarke:]

Sure. I said it before. Obviously with the amount of capacity in this industry new truck pricing it’s competitive and our customers are big and getting bigger. It is always going to be competitive. Our goal is to continue to maintain competitive pricing and certainly provide our customers outstanding value. And that’s what the new product gives us an opportunity for us. So, we’re very excited about that and that’s going to be the key driver for us. But if your question is anybody out there making – doing bad deals I would tell you the answer is no.

[Seth Weber:]

Okay. That’s helpful. Thanks. And just a clarification on the mid-year rollout for the 826. Is that mid calendar year or mid fiscal year?

[Troy Clarke:]

Calendar year.

[Seth Weber:]

Okay. Thank you very much.

[Operator:]

Thank you. [Operator Instructions] I’m seeing no other questioners in the queue with this time. So I’d like to turn the call back over to Troy Clarke for closing comments.

[Troy Clarke:]

Okay. Well, hey, thank you very much for your time this morning. It’s been an interesting quarter for us but again I hope you can tell a quarter that we actually exceeded our own expectations at least internally. I’ll just withdraw everyone's attention to the fact that the quarter has declined significantly in the last calendar year quarter of last year and yet due to environment I think we were able to keep our product programs on track, couldn’t find a better time to launch I think the LT product especially as we anticipate some level of market recovery through the end of the year or through the remaining course of this year. I’m telling you, I said it once, I will say it again, we are very exciting, it is a very exciting time to be at Navistar why wouldn’t it be, right. We have new products, we have increased consideration, we have some level of market recovery on the horizon. And last but not least we finally completed the new alliance with a very capable and great partner. So we appreciate your time this morning and we look forward to reporting more progress at our next quarterly earnings call. Thank you very much for your time today.

[Operator:]

Ladies and gentlemen, thank you again for your participation in today’s conference. This now concludes the program and you may now disconnect at this time. Everyone have a great day.